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Palo Alto Networks, Inc. (NYSE:PANW)
Q1 2018 Earnings Conference Call
Nov. 20, 2017, 1:30 p.m. PT

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Palo Alto Networks Fiscal First Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Kelsey Turcotte, Vice President of Investor Relations. Please go ahead, ma'am.

Kelsey Turcotte -- Vice President, Investor Relations

Thank you. Good afternoon, and thank you for joining us on today's conference call to discuss Palo Alto Networks' fiscal first quarter 2018 financial results. This call is being broadcast live over the web and can be accessed on the Investors section of our website at investors.paloaltonetworks.com. With me on today's call are Mark McLaughlin, our Chairman and Chief Executive Officer; Steffan Tomlinson, our Chief Financial Officer; Mark Anderson, our President; and Kathy Bonanno, our newly appointed CFO.

This afternoon, we issued a press release announcing our results for the fiscal first quarter ended October 31, 2017. If you would like a copy of the release, you can access it online on our website.

We would like to remind you that, during the course of this conference call, management will make forward-looking statements, including statements regarding our financial guidance and modeling points for the fiscal second quarter and full fiscal year '18, our competitive position and the demand and market opportunity for our products and subscriptions, benefits and timing of new products and subscription offerings, our ability to drive outside growth rates, and trends in certain financial results, operating metrics, mix shift, and seasonality.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future and we undertake no obligation to update these statements after this call. For a more detailed description of factors that could cause actual results to differ, please refer to our Annual Report on Form 10-K, filed with the SEC on September 7, 2017, and our Earnings Release posted a few minutes ago on our website and filed with the SEC one Form 8-K.

Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. For historical periods, we have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the supplemental financial information that can be found in the Investors section of our website located at investors.paloaltonetworks.com.

We'd also like to inform you that we will be participating in the Credit Suisse 21st Annual Technology, Media and Telecom Conference in Scottsdale, Arizona, on November 30th; the Raymond James 2017 Technology Investors Conference in New York on December 4th; the 2017 Wells Fargo Tech Summit in Park City, Utah, on December 6th; Barclay's Global Technology Media and Telecom Conference in San Francisco on December 7th; and the Cowen Networking and Cybersecurity Summit in New York on December 13th.

Finally, once we have completed our formal remarks, we will post them to our Investor Relations website under Quarterly Results.

And with that, I'll turn the call over to Mark.

Mark McLaughlin -- Chairman and CEO

Thank you, Kelsey. And thank you, everyone, for joining us this afternoon for our Fiscal First Quarter 2018 results. I'm pleased to report that we delivered a strong start to the fiscal year. On a year-over-year basis, Q1 revenue was $505 million, up 27%. Billings were $596 million, up 15%. Non-GAAP earnings per share was $0.74, up 35%.

In the quarter, we saw a healthy demand environment in all theaters, as well as strong customer interest in all of the extended capabilities of our Next-Generation Security Platform, from network, endpoint, and cloud. The go-to-market changes we made in mid-year fiscal '17, which were designed to drive growth and leverage its scale, are paying dividends for us and our channel as we start off our new fiscal year.

In the quarter, we added over 2,500 new customers and are now privileged to serve over 45,000 customers globally. In addition to strong new customer acquisition, we also continue to rapidly increase the wallet share of our existing customers. Our top 25 customers each spent a minimum of $23.2 million in lifetime value in Q1, which is a 53% increase over the $15.2 million in Q1 of fiscal '17.

The rapid growth and adoption of our platform results from our relentless focus on innovation and our customers. Specific examples of customer wins and competitive displacements in the quarter included a seven-figure competitive win against Cisco and a virtualized data center deal with a US military organization; the Cisco displacement as the security vendor at one of the world's busiest airports, based in EMEA; a Check Point displacement at one of the world's largest technology companies, to become its global security platform; a Check Point displacement in the data center of one of the world's leading payment processors based in the United States; and a Symantec displacement in an endpoint deal for 10,000 workstations at a US federal agency that also included AutoFocus.

There are three hallmarks to our platform that are increasingly well understood by customers and prospects. The first is our ability to provide increased prevention through automation orchestration. Second, is our ability to deliver these security outcomes consistently across on-premise, endpoint, cloud, and hybrid environments. Third, is our demonstrated ability to continually push the boundaries to simplify consumption models at a time when organizations are struggling to balance security needs with limited operational manpower and budgets.

To accomplish these objectives, we continue to drive disruptive evolutions in the market that are designed to meet today's most challenging security requirements and that build on each other over time to establish significant competitive differentiation.

To that end, we introduced two new offerings in September. First, GlobalProtect Cloud Service, which delivers the Palo Alto Networks' Next-Generation Security infrastructure for remote offices and mobile users as a cloud-based service. This offering opens up new use cases for us to help widely distribute to organizations, improve their security, and reduce complexity.

Also in late September, we introduced the Palo Alto Networks' Logging Service, our cloud-based offering that stores context rich logs generated by our security platform. Managed seamlessly with our existing Panorama management product, the Logging Service is the foundation of our application framework, which is the next major evolution in security.

We expect our application framework to provide a new model for the delivery of security applications that can apply advanced analytics to massive datasets and have automated workflow decisions enforced through already deployed capabilities in the network, on the endpoint, and in the cloud.

We have received great feedback from the hundreds of customers briefed on the application framework, which we are on track to deliver in the first half of calendar 2018. Initial reception to GlobalProtect Cloud Service and the Logging Service has been strong and we are very pleased to have closed several deals in the first quarter.

In addition to our new services, we've further enhanced the capabilities of Traps, our advanced endpoint protection offering, with the introduction of Version 4.1. Among the many new features, 4.1 added behavior based ransomware protection, enhanced kernel exploit prevention, and local analysis for macOS.

And, just a few weeks ago, Traps scored a 100% protection rate and earned the Approved Award in the Business Security Report published by AV-Comparatives, an independent organization that tests and assesses AV software. This is yet another third-party validation of our ability to replace traditional AV products.

In October, we expanded the capabilities of Aperture, our cloud access security broker offering. As part of the migration to the cloud, many organizations are adopting a multi-cloud strategy that includes storing large amounts of data within cloud environments, and which requires advanced protections that complement basic native cloud offerings to achieve comprehensive and consistent security. Aperture now provides application protections for several AWS solutions, including Amazon EC2, AWS Identity and Access Management, and Amazon S3.

We also enhanced our support for Office 365 and Google application to include cloud-based email services in G Suite marketplace applications. We continue to see very good traction with customers as they look to us to help them work through the requirements of security in a hybrid world.

Also, we were recently honored to be named a Fortune magazine's list of top 50 companies changing the world and to the Fortune Future 50 list. These acknowledgments further underscore our commitment to innovation and our dedication to improving security outcomes for our customers.

I also want to welcome Kathy Bonanno as our next Chief Financial Officer. Kathy joined our team in 2014 and is currently Senior Vice President of Finance, responsible for financial planning, treasury, enterprise risk management, and facilities. With more than three years at Palo Alto Networks, a decade in cybersecurity, and 30 years business experience, she has an intimate knowledge of our company, the industry, and broad expertise across financial disciplines, as well as a proven track record of building world-class organizations. Congratulation, Kathy. I look forward to continuing to work with you.

Kathy Bonanno -- Incoming CFO

Thanks, Mark. I'm excited about this role and my work with the team. I believe we have a truly unique opportunity to continue to disrupt the security market, take share at scale, and increase operating leverage. I will be several of the upcoming investor conferences and look forward to meeting those of you I don't already know.

Mark McLaughlin -- Chairman and CEO

Congratulations again, Kathy. I look forward to you taking the reigns of the job from Steffan this coming Wednesday. Before I conclude, I want to thank our customers and partners for their support and our team for the dedication to our mission, which is to protect our way of life in the digital age.

With that, I'm going to turn the call over to Steffan.

Steffan Tomlinson -- Outgoing CFO

Thanks, Mark. I'd like to add my congratulations to Kathy, as well. I've really enjoyed working with you and I know you'll be successful in your new role. Now, let's turn to the numbers and guidance. I'd like to note that, except for revenue and billings figures, all financial figures are non-GAAP and growth rates are compared to the prior year periods unless stated otherwise.

In the first quarter, we delivered a strong performance against our land-and-expand go-to-market model. In addition, the power of our hybrid SaaS model was evident in record deferred revenue that continues to be driven by our ongoing mix shift to subscription and support year-over-year non-GAAP operating margin expansion, which drove 35% growth in non-GAAP EPS, and very healthy free cash flow generation.

As we look to the balance of the fiscal year, we're pleased with our improving execution and widening competitive positioning, which is further differentiated by our new offerings. In Q1, total revenue grew 27% to $505.5 million. Looking at the geographic growth of Q1 revenue, the Americas grew 25%, EMEA grew 35%, and APAC grew 25%. Q1 product revenue of $186.5 million grew 14% compared to the prior year.

Bales of the new hardware, which we launched in fiscal Q3 '17, continue to perform well as we land new customers and upsell them into our existing customer base. Q1 SaaS-based subscription revenue of $169.3 million increased 40%. Support revenue of $149.7 million increased 32%. In total, subscription and support revenue of $319 million increased 36% and accounted for a 63% share of total revenue, which was a 420-basis point increase compared to last year.

Q1 total billings of $596.5 million increased 15%. Total deferred revenue at the end of Q1 was $1.9 billion and increased 37%. Q1 gross margin was 76.8%, a decrease of 260 basis points, compared to last year and within our target range of 75-78%. The decline was primarily attributable to the ongoing traction we're seeing with the new products introduced in the third quarter of last fiscal year.

Q1 operating expenses were $292.4 million, or 57.8% of revenue, which is a 360-basis point improvement year-over-year, driven primarily by ongoing increasing leverage in sales and marketing. Operating margin was 19%, an increase of 100 basis points.

We ended the first quarter with 4,707 employees. Net income for the first quarter grew 36% to $69.8 million, or $0.74 per diluted share. On a GAAP basis for the first quarter, net loss increased 12% to $64 million, or $0.70 per basic and diluted share.

Turning to cash flows and balance sheet items, we finished October with cash, cash equivalents, and investments of $2.3 billion. During the first quarter, we repurchased approximately 861,000 shares of common stock at an average price of approximately $145.00 per share, leaving a balance of approximately $455 million available for ongoing repurchases through December 2018.

Turning to cash flow, Q1 cash flow from operations of $274.1 million increased 35% and included the receipt of a $38.2 million upfront cash reimbursement related to certain of the company's lease agreements.

Capital expenditures in the quarter were $32.2 million, including $11.2 million of Capex related to our new headquarters. Free cash flow was $241.9 million, up 32% at a margin of 47.9%. On an adjusted basis, excluding the upfront cash reimbursement and investment in our new headquarters, free cash flow was $214.9 million, up 16% at a margin 42.5%.

DSO was 70 days at the low end of the target range of 70-80 days. Turning now to guidance and modeling points, this guidance takes into account the type of forward-looking information that Kelsey referred to earlier. For fiscal Q2 '18, we expect revenue to be in the range of $518-528 million, an increase of 23-25% year-over-year; product revenue to be in the range of $185-188 million, an increase of 10-11% year-over-year; billings to be in the range of $640-655 million, an increase of 14-17% year-over-year; non-GAAP EPS to be in the range of $0.78-0.80 using 94-96 million shares; and we expect Capex for Q2 fiscal '18 to be approximately $30 million.

For the full fiscal year '18, we're raising our guidance and now expect revenue to be in the range of $2.145-2.185 billion, an increase of 22-24% year-over-year; product revenue to be in the range of $755-770 million, an increase of 6-9% year-over-year; billings to be in the range of $2.65-2.71 billion, an increase of 16-18% year-over-year; non-GAAP EPS to be in the range of $3.35-3.41 using 96-98 million shares; and we continue to expect Capex to be approximately $100 million.

Before I conclude, I'd like to provide some additional modeling points for the fiscal year. We continue to expect fiscal Q2 and fiscal Q4 to have the strongest sequential total revenue growth. As reflected in consensus heading into this call, our non-GAAP EPS guide continues to include approximately 150 basis points of organic operating margin expansion, excluding first half fiscal year '18 investments associated with the LightCyber acquisition.

And, we continue to expect fiscal year free cash flow margin to be in the range of 37-39% as the nonrecurring cash reimbursement received in Q1 will be mostly offset by rent payments throughout the balance of this fiscal year.

With that, I'll turn the call back over to Mark.

Mark McLaughlin -- Chairman and CEO

Thanks, Steffan. Before we head over to the questions, I wanted to take the opportunity to thank you again for all of your contributions to Palo Alto Networks. You've been an inspiring leader, built a great organization, and you've been a wonderful friend and a real pleasure to work with you. Thank you very much for that.

Steffan Tomlinson -- Outgoing CFO

Thanks, Mark. I appreciate your kind words.

Mark McLaughlin -- Chairman and CEO

With that, why don't we head to questions.

...

Operator, will you please open for questions?

Questions and Answers:

Operator

Absolutely. [Operator Instructions]. Our first question will come from Philip Winslow of Wells Fargo.

Philip Winslow -- Wells Fargo -- Analyst

Hey, thanks, guys and congrats on a great quarter. Obviously, the product number was strong again this quarter and you saw an acceleration from the prior two quarters. I was wondering if you could double-click on the sales practices that you all discussed for the following Q2 and how you feel in terms of the go-to-market right now with the changes you made mid last year -- and then, just one quick follow-up to that.

Mark McLaughlin -- Chairman and CEO

Sure. Phil, we saw a good strong environment in every theater, so we really like the health of the market out there. With being able to go capitalize on that with some of the changes we made last year, which has really taken effect, we're seeing the dividends from that work we started mid last year. We feel good about where we are with that process. We're in what we called the bait phase before, the relationship building phase, which seems to be going very well. We expect that to keep paying dividends for us as we play out the year.

Philip Winslow -- Wells Fargo -- Analyst

I was hoping you all could comment on the pricing environment as well, and any changes you're seeing there as we exit this calendar year -- versus maybe earlier in the year last year. Thanks.

Mark McLaughlin -- Chairman and CEO

It seems the same. It's a very competitive market. We've seen the competition price aggressively for quite some time, and we've seen us be able to continue to sell to the value of the platform. I think customers get that more and more. Our team is trained to do that, and we like the results of that. We've been able to continue to improve product discounting continuously and sequentially, for example. We like to see that as well. It doesn't seem like we have to succumb to all of the pricing machinations that are going on with the competition here as the customers really adopt the entire platform.

Operator

And our next question will come from Pierre Ferragu of Bernstein.

Pierre Ferragu -- Bernstein -- Analyst

Hi, everybody. Thanks for taking my question. When I look at your guidance for next year, you had 6-9% in product and 16-18% in billing. If I make the difference, you're growing your subscription billing 20-23% year-on-year which is very impressive and way above your product growth. My question is, how does that spread between attacked and unattached products? How much of that is still driven by your expansion of your install base of firewall and how much is subscriptions that are not attached anymore?

And my second question would be, if you keep growing like that, subscriptions must faster than products, next year you're going to have less than a third of your billings coming from products. In two or three years out, you'll be at 80% subscription and only 20% product business. Am I right, thinking of it that way?

Mark McLaughlin -- Chairman and CEO

Yes, Pierre. Obviously, we don't guide beyond the year. Let me start with that. But, as a general matter, we've seen our business continue to move into the services category over time, particularly in subscription services, for a few reasons. One is, the platform is very powerful and the customers understand how the subscription services provide better security and reduce the complexity of their consumption models.

Secondly, we continue to introduce new services. We just introduced two in September -- the GlobalProtect Cloud Service and Logging Service. We were happy with the performance already with those. As we continue to bring new services to market, as well, we would see the business move in the subscription services direction as well. And then, on top of that, the application framework -- which will come into the market next year as well -- should also help move things in those directions. So, that's what we would imagine would occur over a period of time. It would keep moving in that direction. But, for the year, we've guided about a 65% split, if you recall from analysts, on revenue, as to what would come from the services side of the business.

Pierre Ferragu -- Bernstein -- Analyst

Thank you.

Kelsey Turcotte -- Vice President, Investor Relations

Next question, please.

Operator

And our next question will come from Rob Owens with KeyBanc Capital Markets.

Rob Owens -- KeyBanc Capital Markets -- Analyst

Great, and thanks for taking my question. Maybe you could give us a little more color on the success you're on the product side of things and what's coming from preexisting customers that are within your original base, versus maybe an increase in competitive wins.

Mark McLaughlin -- Chairman and CEO

Yeah, Rob. Well, we're doing well in both cases. You can see new customer acquisitions continue to be very strong and obviously we're selling product to a lot of those customers -- the vast majority of those, as a matter of fact. So, we continue to bring in new customer wins. Also, the expansion business has been strong for a very long time and is powering the majority of our business just by math, the size of the customer base. The expansion business continues to do well. I feel like we're doing really great in whitespace opportunities, and also convincing our customers to continue to grow the lifetime value with us.

Rob Owens -- KeyBanc Capital Markets -- Analyst

I see much of the upside in the quarter coming from product. The billings were at the high end, but you overachieved on products and total revenue. So, if I looked at billings relative to revenue yield, or I guess the inverse of product with the attached subscriptions, is that product mainly coming from preexisting customers so you don't get as much as a subscription uplift? Or, do you have less attach or less duration to the attach? Maybe you could help provide some color there. Thanks.

Mark McLaughlin -- Chairman and CEO

Yeah, sure. So, just a couple of observations. In the quarter, we're very happy with the product delivery, obviously and total revenue delivery. Also, on the billings side, in the quarter we saw a couple of things going on in the ratio. As we continue to improve the product discounting, then that would put more into the product revenue bucket, so the mix is a little bit higher than we thought we would see in the quarter. Also, in some of our service provider business purchases, some of those were a little more Capex heavy than we forecasted. So, that would put some more into the product bucket as well. So, the mix is just a little different than we expected coming into the quarter.

Operator

And our next question will come from Ken Talanian with Evercore ISI.

Ken Talanian -- Evercore ISI -- Analyst

Hi, guys. Thanks for taking the question. Another one on product. I was wondering if you could give us a sense for how much the VM-Series and Panorama contributed to the product revenue in the quarter and how we should think about that for the remainder of the fiscal year.

Mark Anderson -- President

Yeah, Ken. It's Mark. Very, very little. The VM-Series is primarily -- almost all of it is heading into the subscription services line. That's how we recognize that. It performed very well, by the way, but very little of that goes into product.

Mark McLaughlin -- Chairman and CEO

And the same is true with Panorama.

Mark Anderson -- President

Yeah, same with Panorama.

Ken Talanian -- Evercore ISI -- Analyst

Okay. You delivered double-digit year-over-year product revenue growth in the quarter and are expecting the same next quarter. Is there anything you see in the back half of the year that makes you a little bit cautious?

Mark McLaughlin -- Chairman and CEO

No. We like the way the quarter played out, so we over-delivered on product, which is great. Our forecast looks good in the second quarter and, based on that, we've increased the product revenue guide on a full-year basis. But, it's early in the year, so we'll see it play out a little bit more.

Operator

And our next question will come from Sterling Auty of JP Morgan.

Sterling Auty -- JP Morgan -- Analyst

Thanks. Hi, guys. First of all, Kathy, congratulations. Steffan, great job to finish off your tenure on such a strong note. But, I just wanted to take it to the high level. With the guide out of Check Point, out of QuarterNet, there were all of these concerns about what was happening in the firewall market. Obviously, you put up good results. But Mark, in your comments, you specifically pointed out good demand in all theaters. That's what I want to point to. Can you give us additional color as to the general spending environment for network security, and more specifically, firewalls? There is still this big question in everybody's minds, just how much is the move to the cloud going to hamper, help, or be a non-event to the firewall vendors.

Mark McLaughlin -- Chairman and CEO

Yeah, maybe I'll take that in two different levels, and then I'll ask Mark to talk about the theaters for just a second, which were very strong. At the highest level, we're seeing healthy demand in the market for security, period. I think what's happening is folks are definitely moving in the real platform direction and we feel like we have the best on those and it continues to get better and better over time. If you remember, Sterling, at Analyst Day, we talked about the three evolutions that build on each other and drive continued competitive advantage. That second one in there, which we defined as consistency of security outcomes across not only the network, but endpoints and cloud environments -- whether they're public or hybrid -- is very important.

And, we think customers agree with that. So, we're seeing a good adoption in our cloud offerings, VM-Series, and Aperture as well. But, what folks are offering in a hybrid environment -- I expect them to continue to do that for some time. So, that drives strength in not only the cloud offering, but in what's happening in data centers from a hardware perspective. We see lifts in all of those. Maybe, Mark, you can talk about the theaters?

Mark Anderson -- President

You bet, Mark. So, hey, Sterling. From a geographic color standpoint, we're happy across the board. We saw 25% in the Americas -- by far our biggest theater -- and 25% in APAC and Japan, and 35% in EMEA. So, a really good, strong execution across the board. I think, in all theaters, we're getting tremendous at-bat because we have great geographic coverage in all of the sub regions, and really good partner traction as well. So, we're getting a lot more at-bats -- we're winning the vast majority of those at-bats because we have a much better solution.

I think, with regards to cloud, as we said pretty clear at Analyst Day, we really think there are major tailwinds coming with cloud. We're hearing constantly from customers that they want -- as they move more and more off of prem, over the long-term, they're going to want consistent delivery of security. That's what we've been talking about for a long time and we think we're pretty unique in that.

Operator

And our next question will come from Matthew Hedberg of RBC Capital Markets

Matthew Hedberg -- RBC Capital Markets -- Analyst

Hey, guys. Thanks for taking my questions. Kathy, I'll offer you my congratulations as well. Mark, we continue to hear good things about GlobalProtect Cloud Services and you highlighted in your prepared remarks. Could you talk a little bit more about the competitive landscape there? What are some of the opportunities? And then, I have a quick follow-up.

Mark McLaughlin -- Chairman and CEO

Yeah, sure. I think the way to think about that, Matt -- and the way we certainly think about it -- is we want to make sure that, for our customers, when they want to consume the platform, those consumption models are as broad and as flexible as possible. So, for a long time, we've offered those capabilities from an on-prem perspective that people want to manage themselves. We've had that with MSSP partners, where it can be managed by a third party, and now with GlobalProtect Cloud Service, we give them an option of having that totally as a cloud experience.

We continue to evolve all of the offerings based on what the customer needs will be into the future. So, if I step back from that a second and say, "Okay, what are we doing?" We're bringing the full-on enterprise security platform in that form factor to the market. That means we're going to be able to provide, and we are providing, the security outcomes we've been driving for some time across all applications, consistently from endpoint to network in cloud and in ways that are just not -- like traffic that's leaving but also coming into the network and being able to bridge the mobile user. So, a pretty distinct competitive advantage there. Also, flexibility on a new model, that customers' reactions have so far been very positive.

Matthew Hedberg -- RBC Capital Markets -- Analyst

That's great. And then maybe just a quick one. Could you comment on the relative rate of sales capacity ads in Q1 relative to your 15% billings growth? Was it less, more, or about the same?

Mark McLaughlin -- Chairman and CEO

Nothing out of the norm historically, so very consistent with what we've been doing for many years.

Operator

And our next question will come from Saket Kalia of Barclays.

Saket Kalia -- Barclays Capital -- Analyst

Hey, guys. Thanks for taking my questions here and congrats, Kathy, on the promotion as well.

Kathy Bonanno -- Incoming CFO

Thank you.

Saket Kalia -- Barclays Capital -- Analyst

Hey, Mark, maybe just to start with you -- high level. Understanding it's still early days on application framework, how is application framework maybe changing customer conversations, if at all, at this juncture?

Mark Anderson -- President

It's been really dramatic, Saket, in a positive way. When we're talking with customers and we start off, it's always at a very high level to say, "Palo Alto, for the last decade, has been fundamentally bringing higher and higher rates of prevention through automation and orchestration. In addition to doing that, we've also been masterfully simplifying the consumption model along the way so the customers can have better security with a much simpler consumption model which drives better ROI and less manpower -- all of things that we've believed is important for a long time." The world completely agrees with that now, with the models the way they are. They're really broken in half to be fundamentally different.

And then, to show them the way for the third evolution with the application framework, to say, "Imagine a world that looks like this, where you don't have to give up getting lots of innovation from the security market because security has to be highly innovative but no one company can do that. Here's a way to get even more automation, more orchestration, better prevention rates, and do it with a vastly simplified consumption model." They really like that.

I think what that's doing for us right now is very much showing what the future's going to look like as the thought leader. We have lots of demonstrated capability in making those real. We have people writing applications in the application framework today and we always have to keep in mind, after that conversation, they're going to buy something this afternoon. It might be a firewall, an endpoint solution, a virtual machine in the cloud, or something along those lines for a project. I think we're hearing them say that we've given them a very significant reason why they want to choose Palo Alto Networks operating platform in all places in their architecture for our security capabilities.

Operator

And our next question will come from Gabriela Borges of Goldman Sachs.

Gabriela Borges -- Goldman Sachs & Co. -- Analyst

Good afternoon. Thanks for taking my question. Maybe a follow-up on the demand picture. But, instead of geographically, by vertical -- so maybe if you could comment a little bit on federal, carrier mid-market. I think that was the comment earlier on some of the mix being better toward product because of Capex from service providers. So, if you could just talk a little bit more about the demand profile and the mix you're seeing across the vertical, that would be helpful.

Mark McLaughlin -- Chairman and CEO

Sure thing. First, we're very well diversified across our verticals, which is great We like to see that. Mostly, it demonstrates that we're truly a platform because you see that horizontally played out across all verticals. From a fed perspective, the fed year-end, we saw some good winds there. And, continuing to see increasing signs of spending getting back to normal, which would be fantastic. There have been a lot of ups and downs and anxiety in the fed market, due to lack of leadership positions being filled. We're in containing resolution right now, so any return to normalcy is a good thing there.

Also, the feds base fits very well within our mission, for what we do, which is to protect our way of life in the digital age and what the federal government's trying to do. They find that to be very in line with their mission, so they like that a lot. On a service provider side, that's a good market for us. It continues to grow nicely. We continue to put more investment in there from a technology perspective of adding features and functionality to that. My comment earlier on prepared remarks on service providers, was that the product mix of the deal sets in the service providers, is heavier than we thought in the quarter and that contributed some to the product mix in the quarter, which we like to see, of course.

Operator

And we'll hear next from Michael Turits of Raymond James.

Michael Turits -- Raymond James -- Analyst

Hey, guys. Two questions. First of all, I think this is a continuation of Rob Owens' question, asking about new versus existing. Can you give us some sense of where you are in that refresh cycle coming off of your build, where product was really strong back in the 2012-2013 era and where you might be, and if that's on track? And then, I have a follow-up question about billings.

Mark McLaughlin -- Chairman and CEO

Sure. From a refresh perspective, the refresh opportunity, as we've said before, is large and continues to grow. When we add this many customers and their cohorts grow over time, that's been going well for us. We had good refresh in the quarter and we expect that to continue through the rest of the year. We also mentioned -- Michael, you may remember on Analyst Day, that we wouldn't expect that to be the major driver of our product growth in the year. We expect that to be the platform itself or new product introductions and increasing productivity from the sales team with reorg. But, the refresh is definitely a positive for us and we're doing very well on that.

Operator

And our next question will come from Patrick Colville of Arete Research.

Patrick Colville -- Arete Research -- Analyst

Thank you for taking my question. Is there any way you can tell us, or give an indication of the product revenue blend from the new hardware launch in the first of '17?

Mark McLaughlin -- Chairman and CEO

I'm sorry, Patrick. I'm not exactly sure I understand the question.

Patrick Colville -- Arete Research -- Analyst

So, of the product revenue you saw in the quarter, what portion roughly was from the new hardware you launched early this year?

Mark Anderson -- President

The new products we launched had very healthy contributing factors to the mix of product. We don't give out specific percentages, but the traction has been very strong. It's opened up new opportunities to sell to new customers, as well as selling into our install base from an expansion standpoint. So, it was a very strong contributor, we just don't give out the specific percentages.

Operator

And our next question will come from Andrew Nowinski of Piper Jaffray.

Andrew Nowinski -- Piper Jaffray -- Analyst

Great, thanks. Congratulations, Kathy. Just a clarification. Your product gross margin as a little bit lower than it has been historically, which I think you said was due to the new hardware. But, when do you expect to start seeing the cost deficiencies from the new products -- where they're no longer a headwind to your gross margin?

Mark McLaughlin -- Chairman and CEO

Well, we said earlier when we had new product launches, we would have some headwinds on product gross margins as we got the economy to scale, and also that our provider -- people who supply us with components -- can also take those components into a broad base, into the market. When we look at the size of the product launch we just did back in February, it's the biggest one we've done by a longshot. So, we don't have the perfect analogy on that. But, probably the closest one is the 5000-Series we did a number of years ago. That took about a year or so before we were able to get those economies to scale. And we expect that to be the case here.

Steffan Tomlinson -- Outgoing CFO

Just a follow-on point, with that being the dynamic, we're still operating within our framework of 75-78% total gross margin and we've incorporated that dynamic into that guidance range. So, we feel good about that structure.

Operator

And our next question will come from Gur Talpaz of Stifel.

Gur Talpaz -- Stifel -- Analyst

Great. Thanks for taking my question. A quick question on endpoint. Do you think we're at the point now where large enterprises are more willing to buy endpoint prevention and networking security from the same vendor? Are you seeing more in the way of standardization projects, thinking perhaps in the quarter?

Mark Anderson -- President

Yeah, Gur, it's Mark. Yeah, I think that's the case. We believe, just as a big-picture matter, that that's definitely going to be the case in the future. We leaned very heavily into the endpoint market, as you know. We think it's by matter of necessity. And, when you think about that second evolution, the way we defined it, of consistency from network to endpoint to cloud, that's going to be very important. Some capabilities, from a security perspective, are better done on a network and some are better done on endpoint. Increasingly, with data in the cloud, some will be in the cloud.

So, we have to get all of those right, and very importantly, they all have to work together. We're seeing that customers want that consistency. I think they also want fewer vendors as a big picture matter, as well. So, being able to have a platform that has that consistency that allows them to reduce the number of vendors and sprawl in the organization -- that might be devices in a network or agents on an endpoint -- is a net positive for them.

Operator

And Gregg Moskowitz of Cowen & Company has our next question.

Gregg Moskowitz -- Cowen & Company -- Analyst

Thank you. Congrats on a good quarter. Congrats, Kathy. Best of luck, Steffan. I'd like to go back to new customer acquisition because this was an impressive quarter on that basis, and especially so for Q1. We do attribute this to the product refresh earlier in the year. Would you also say there's a more concentrated go-to-market focus around reaching new accounts? Thanks.

Mark McLaughlin -- Chairman and CEO

I think we have a number of things that are going on, Gregg. We had solid performance from all of the theaters, you heard a little while ago, across all of the customer profiles. We've got our continued productivity improvements, as well, from the work we started last year, with the new product for sure getting a positive reception in the market. And also, with increasingly growing the bed of offerings with our new services, we have the ability to talk to customers about new opportunities and land new customers with nonattached services as well. So, we have a whole bunch of stuff going on as far as the ability to touch customers and new products are definitely contributing nicely inside of that.

Gregg Moskowitz -- Cowen & Company -- Analyst

Okay. Thanks.

Operator

And our next question will come from John DiFucci with Jefferies.

John DiFucci -- Jefferies -- Analyst

Thank you. I have a follow-up question from Gur's question. It has to do with Traps. It looks like you're seeing some good traction. And, by the way, this question is, I think more for Mark Anderson. That Symantec displacement is really interesting. I assume, when you're in conversations with customers, they're first buying your firewall and everything that comes along with that and then they consider Traps. But, I guess, is that accurate? And, have you ever seen -- I assume when they look at Traps -- are they comparing Traps on its own merits against Symantec? Mark McLaughlin just talked about having both his -- it has some advantages. But, do they also consider it on its own merit against the competing product, and do you think it will ever be the land product? Like, "Hey, I want to buy Traps, and then maybe I'll consider the firewall?"

Mark Anderson -- President

Yeah, hey, John. Thanks for the question. First of all, about a third of our customers for Traps, their first purchase is Traps and not traditional network security. We think, on the merits of the solution, with the focus that we have in the field, that we're winning because we're delivering better outcomes and we're going after traditional antivirus budget because customers have associated very little value with the money that they're spending on traditional antivirus. I think, down the road, it's a really strategic space for us and, as Mark mentioned earlier, we're going to continue to see success here.

Mark McLaughlin -- Chairman and CEO

One other thing, John -- and this is important for our teams as they're out there making these sales -- is the ability to tell a customer to say -- this second evolution, the way we defined it earlier, is really important to have consistency of the security outcomes, regardless where the data is. And some of it's going to be on an endpoint. We definitely want that consistency. And also, to be able to say, on a head-to-head basis, we're the best there. So, you should choose us on a competitive bake-off, which we know you're going to do, and we feel very good about that. As you think about that bakeoff, in addition to winning head to head, you also get the consistency aspect that allows you to grow into the future, into even more interesting things like the application framework over time.

There are more reasons why you want to deploy Palo Alto Networks everywhere that's important as a data collection point, and then, of course, your architecture -- sometimes network, sometimes endpoint, sometimes in the cloud.

Mark Anderson -- President

And, it's truly the trust and faith that we've earned from customers over the last decade, where they know that we're going to provide a high-quality product and then we're going to support it in a more focused way than anybody out there can, from a product support standpoint.

John DiFucci -- Jefferies -- Analyst

Great. Thank you, guys.

Operator

And our next question will come from Fatima Boolani of UBS.

Fatima Boolani -- UBS -- Analyst

Thank you for taking my question. Mark, a question for you around your dedicated effort around building a public cloud practice and bringing your partners in there. Just at a high level, I'd love to hear what sort of conversation you are having with the customers around their public cloud challenges and how you are positioned to help them cross the chasm. And a quick follow-up for Steffan, if I may.

Mark Anderson -- President

Yeah, you bet, Fatima. We have a really broad spectrum of customers. Some are leaning pretty aggressively into public cloud. They're putting pre-productive dev ops and new applications into the cloud. Some are dipping their toes. I think what we represent for them is an opportunity to provide a real consistent look and feel for the security that we can impose there. This is going to take place over the next five to ten years, where you're going to continue to see more and more migration as people become more and more comfortable for that. I think the comfort is going to come from the kind of security that we can help deliver to them. So, I think we're in a very good space there.

Fatima Boolani -- UBS -- Analyst

That's helpful. Steffan, if I look back to your billings performance a couple of years ago, where you maybe signed some longer termed contracts, as those come up for renewal in '18 and even '19, what sort of trends are you seeing in the earlier crop of these longer-term deals? Are they renewing at the same duration? That would be really helpful. Thank you.

Steffan Tomlinson -- Outgoing CFO

Well, if you look back over the last several years, we've seen a modest, gradual increase in duration. It seems to have leveled out at approximately three years. For the companies who did a three-year deal three years ago, there is really a mix of renewals business right now. We're seeing some reup for a multiyear term. We're seeing others renew annually. There is a mix there. But, what we said at our Analyst Day, and what we still believe to be true, is that, for the rest of the fiscal year, we don't' see any changes in the overall duration and it should be roughly about three years.

Operator

And our next question will come from Walter Pritchard with Citi.

Walter Pritchard -- Citi -- Analyst

Thank you. As I look at revenue per customer, you highlighted your large -- I think it's $23 million to be a top 25 customer. Can you talk about what's happening at the other end of your business? With some of the lower end products released in the last six months, are you dipping down into smaller customers at all? What is your strategy around -- I know you're not a small office player, but when do you look to potentially turn into that segment of the market, where there's probably some revenue opportunity for you?

Mark Anderson -- President

Hey, Walter, it's Mark. Our focus has, and continues to be, as you know, enterprise security market, mostly because we find focus matters in delivering the best solutions and we're being able to support them in a high-quality manner. That hasn't changed for us. We look at the customer acquisition into the mix of customers as are they very consistent with what it has been for some time. We haven't seen a change there.

I think what we are seeing from some use cases of some of the larger customers is the ability to address interesting and new use cases around -- like in retail environments. Plus, some of the new services want to be able to do some more campus work and mobile user work and things along those lines. We'd expect that to continue.

Walter Pritchard -- Citi -- Analyst

A question for Mark Anderson -- just for now, in the European theater, that looked especially strong. Was there anything specific. Sometimes, good execution is the answer, but I'm curious if there's anything specific you're seeing in certain countries and certain vertical markets that might explain the strong performance in Europe.

Mark Anderson -- President

No, it was a really good performance across the board in every sub-region within the immediate, Walter. I think, just what we're seeing across the board, in Europe, is they're typically one to two years behind the Americas in terms of their IT culture, if you will. We're seeing general awareness of the need for migration away from legacy disconnected products to more of an architecture approach.

I think it's coming at a time when bad things are happening around the world, with the focus on legislation with the GEPR and, frankly, the coverage that we have now in every major country and in Europe that's getting us in front of customers and showing them how we can be a much better provider for them.

Walter Pritchard -- Citi -- Analyst

Great. Thank you.

Operator

And our next question will come from Keith Weiss of Morgan Stanley.

Keith Weiss -- Morgan Stanley -- Analyst

Hey, guys. Thanks for fitting me in. Very nice quarter. Just on the go-to-market strategy, it seems like the differentiation in the sales -- sort of what you're selling to the customer base is changing in a big way. This isn't an appliance sale anymore. It's not a box sale anymore. You guys are selling a platform. Does this change the partner strategy at all, or change the kinds of partners you're going to market with in terms of who could actually get across that value proposition?

Mark McLaughlin -- Chairman and CEO

Certainly, we're always on the lookout for -- searching for, frankly -- new partners. We're not looking to cast a wide blanket, but looking to improve the coverage we have around the world. So, it just naturally -- as we've grown -- the kind of partners that we couldn't address -- the large global ones, the large systems innovators -- seven or eight years ago, now we're at the scale where it's hard for them to avoid us, frankly. We've worked really hard on that in the last five years and, as we've discussed in each of the Analyst Days, we're getting more and more attention there.

But, I'd say nothing really dramatically different than the last Analyst Day other than just very much a focus on looking for large global distribution partners, large global systems integrators, service provider partners, and national brands. We do want a message that's consistent with what our field team is talking to customers about, this platform or architecture delivery versus just disconnected point products.

Keith Weiss -- Morgan Stanley -- Analyst

Got it. One follow-up on the federal vertical in particular. Any color you can give us on the strength of federal in Q1 and, given current machinations with budgeting or whatnot, expectations for the potential to continue that strength further into the fiscal year?

Mark Anderson -- President

Yeah, Keith. Mark, again. In the fed space, like I said, we saw some good winds in the quarter. I would say big picture, it's been a mixed bag for a number of quarters as there's been some consternation, I think, in the federal space on some senior leadership positions that still go unfilled. Also, just the budget. We're still working under a continued resolution right now that I don't think gets fixed until a December timeframe.

But, the progression of seeing more normal spending and people understanding what their budgets will look like for the following year is very important. So, hopefully, getting through the continued resolution would be a positive marker on the table and get people back to more normal spending patterns there.

Mark McLaughlin -- Chairman and CEO

And, I would add, it's a really important space for us to be in. We've invested in the team over the last three years and we've got great coverage across the Intel, Pavilion, and DOD segments. That makes me feel really good about the team.

Keith Weiss -- Morgan Stanley -- Analyst

Excellent. Thank you very much, guys.

Operator

And our next question will come from Karl Keirstead of Deutsche Bank.

Karl Keirstead -- Deutsche Bank -- Analyst

Thanks. For either Mark, I wouldn't mind going back to the relative performance. It feels like, for this quarter and the one you're guiding to, the gap between yourselves and Check Point seems to be widening. I just want to ask if you can help us understand exactly where that wedge seems to be opening up. Is it as simple as you've got a product cycle benefit that perhaps they don't now? And then, maybe, as a follow-up to Steffan -- to build on a prior question, you raised the revenue guidance but the billings guidance, at least at the high end, is essentially the same. Is that simply because most of the DR comes from maintenance and subscription and those line items were a little bit more in line versus the outperformance on product? Thank you.

Mark Anderson -- President

Yep. I'll take the first part. I think what we're seeing in the market, and have been for a while, is the importance of the platform, which I mentioned before, where things work together in a highly automated and orchestrated fashion and there are really positive benefits in prevention outcomes plus the simplicity of the consumption models that result -- I think that continues to distinguish itself in the market, because anybody can make those statements, but at the end of the day, what really matters is the architecture of how it's actually built.

I think that what we've proven over time is we get a lot of credibility there because we're a company that primarily is working on developing and building those things ourselves so we can make those statements at scale to customers and say, "No, we really think works together and we have lots of references you can talk to. Where other companies might be cobbling things together and try to do things that really don't work out at the end of the day, we're getting to an automated platform."

I think that's one level of it. The second thing on the architecture is the elegance of the architecture matters as well. From a simplicity perspective, having it work in that automated, orchestrated way, where you're mostly in charge of that platform -- you built a lot of it yourself -- matters from a stability perspective, too. We increasingly, as other vendors add more acquisitions into the mix, that stuff doesn't really work well together. Not only does it not drive the security outcomes, but it drives increasing instability in networks as well. We hear a lot of folks coming to Palo Alto Networks saying one of the primary reasons is not just technical but also stability. "My current provider can't run at these big scales any longer. They just keep adding more stuff and it's starting to break things."

So, there's a whole bunch of stuff in the mix of that, but it all comes back to the architecture of the platform as the primary differentiator. As we drive these three evolutions and they build on each other, we think that increases the moat and, over time, we'll continue to distinguish ourselves.

Steffan Tomlinson -- Outgoing CFO

Karl, on the second part of your question, as you mentioned, we did raise billings for the full year by $10 million. The mechanics are such that, when you look at our deferred revenue balance and what we're adding to it every quarter, it's very robust and healthy growth in both attached and nonattached subscriptions and maintenance. They're coming in line as expected and, to the point that you raised, we are having more in period revenue than we had originally planned for because product has grown so strong. So, we also raised product for the full year. The last point I'll leave you with is, if you think about current billings, it was strong and that reflects product revenue in the period versus the change in short-term deferred.

Karl Keirstead -- Deutsche Bank -- Analyst

Got it. Okay. Thanks a lot.

Operator

And our next question will come from Shaul Eyal of Oppenheimer.

Shaul Eyal -- Oppenheimer & Co. -- Analyst

Thank you. Good afternoon, guys. Congrats on a good quarter. Congrats, Kathy on the recent promotion. Steffan, thank you for everything. Steffan, before we let you go, just a quick housekeeping. The number of customers relating to Traps and Wildfire -- I think you have been providing that. Any view, any update, along these lines?

Steffan Tomlinson -- Outgoing CFO

Yeah, on that front, we release those on a semiannual basis. We saw a very healthy growth in customer accounts for both of those product lines.

Shaul Eyal -- Oppenheimer & Co. -- Analyst

Fair enough. Mark, you mentioned in your prepared remarks an expansion of your cloud products. I think you also mentioned including them in an updated email version targeting Office 365 landscape among other things. Does that product fall under your successful partnership with Proofpoint?

Mark McLaughlin -- Chairman and CEO

Yeah, Shaul, what I mentioned is that for our Aperture offering -- which is our cloud access security broker offering -- we continue to expand the applications, APIs, that it's worked with. We expanded it into cloud-based email offerings like Gmail, for example. Just think of them as we keep adding more application coverage to Aperture.  

Mark Anderson -- President

But there is integration with Proofpoint that would -- when we can make this discovery with Palo Alto Networks, the integration we do with Proofpoint can allow Proofpoint to actually do something about it. It really is an add for Proofpoint.

Shaul Eyal -- Oppenheimer & Co. -- Analyst

Got it. That is helpful. Thank you.

Operator

And our final question will come from Jonathan Ho with William Blair.

Jonathan Ho -- William Blair -- Analyst

Hi. Congratulations. In your early data link and application framework deals, can you maybe give us a little bit of color in terms of what those deals look like and the potential for upsell and expansion over time?

Mark McLaughlin -- Chairman and CEO

Sure. I'll take that. Mark is very involved in some of these and can give you some more color. Big picture on the third evolution, Jonathan, of bringing the application framework to market may be somewhat of an obvious statement, but definitely are reinforcing it with customers. If you're going to have capability sets that are really based on analytics and increasingly lots of interesting things, and security will be driven on analytic capability and machine learning capability, the dataset against which it runs is very important, not only in terms of its size, but also in the diversity of the kind of data in there.

For example, you don't need machine learning to tell you information's bad if the only dataset you put in there was bad stuff. So, you want to have very big datasets and you want the diversity of the dataset to have good, bad, and unknowns in there and grow a lot over time. So, the Logging Service is a capability set that we get to go to customers and say, "From a very cost-effective point of view, you can log all the information coming off Palo Alto Networks' capabilities because you want those really large datasets for all of the analytic capabilities like LightCyber, for example, and things will bring the application framework to chew on those." The bigger they are, the better they are, and it doesn't have to be cost prohibitive to log all of that information. Mark was deeply involved in a couple of the sales this quarter, so maybe you want to add --

Mark Anderson -- President

Yeah, I think you pretty much nailed it, Mark. To be able to leverage machine learning, like our adversaries are leveraging against our customers every day, in an increasing scale and velocity, you need to be able to log not just bad and suspected bad, but also good to let the machine crunch, as Mark said. I think, what makes us attractive beyond price is the fact that we're able to take the data from Logging Service and add that to the trillions of artifacts we have in our threat intelligence data centers around the world, to really drive the kind of automation you need to be able to reduce the attack surface.

Mark McLaughlin -- Chairman and CEO

I think that's the last questions. Okay, well thanks. Before I close, I want to thank everybody again for joining us today. I wish you and your families a very safe and happy Thanksgiving. We look forward to seeing many of you in the coming December investor conferences. We really appreciate your time. See you next time.

...

Operator

And, Ladies and Gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.

Duration: 59 minutes

Call participants:

Kelsey Turcotte -- Vice President, Investor Relations

Mark McLaughlin -- Chairman and CEO

Steffan Tomlinson -- Outgoing CFO

Mark Anderson -- President

Kathy Bonanno -- Incoming CFO

Ken Talanian -- Evercore ISI -- Analyst

Michael Turits -- Raymond James -- Analyst

Walter Pritchard -- Citi -- Analyst

Philip Winslow -- Wells Fargo -- Analyst

Pierre Ferragu -- Bernstein -- Analyst

Rob Owens -- KeyBanc Capital Markets -- Analyst

Jonathan Ho -- William Blair -- Analyst

John DiFucci -- Jefferies -- Analyst

Gur Talpaz -- Stifel -- Analyst

Sterling Auty -- JP Morgan -- Analyst

Patrick Colville -- Arete Research -- Analyst

Fatima Boolani -- UBS -- Analyst

Karl Keirstead -- Deutsche Bank -- Analyst

Matthew Hedberg -- RBC Capital Markets -- Analyst

Saket Kalia -- Barclays Capital -- Analyst

Andrew Nowinski -- Piper Jaffray -- Analyst

Shaul Eyal -- Oppenheimer & Co. -- Analyst

Keith Weiss -- Morgan Stanley -- Analyst

Gabriela Borges -- Goldman Sachs & Co. -- Analyst

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